OGX Nightmare in Brazil: Niko shareholders should take heed!

Here’s How Batista’s OGX Nightmare Gets Worse for Pimco

By Peter Millard and Juan Pablo Spinetto - Sep 12, 2013

As creditors led by Pacific Investment Management Co. try to salvage what is left of their stake in Eike Batista’s oil ambitions, the specter of ATP Oil & Gas Corp.’s demise underscores how much more they stand to lose.

With $3.6 billion of OGX Petroleo & Gas Participacoes SA (OGXP3)’s bonds trading at 18.75 cents on the dollar on speculation the six-year-old company will run out of cash after failing to deliver the oil output that Batista promised, the ex-billionaire is now asking investors for at least $250 million in capital and will propose bondholders convert debt into stock to avert bankruptcy, two people with direct knowledge of the matter said.

OGX bondholders, which include Pimco and BlackRock Inc. (BLK), may be better off providing debt relief to Batista while the company’s assets support the notes rather than seeking repayment in bankruptcy court, according to Jason Brady, who helps oversee $89 billion at Thornburg Investment Management Inc. Seaport Group LLC says OGX’s collapse is akin to ATP, the Houston-based oil explorer that sold assets under bankruptcy protection to pay lenders, leaving it with no money to pay $1.5 billion of notes in default since November. The bonds sell for less than a penny.

When OGX began chopping output targets at its Tubarao Azul field, “some people began to talk about similarities with ATP, and it’s proved to be in hindsight a good guide,” Michael Roche, an emerging-market strategist at New York-based broker-dealer Seaport Group, said in a telephone interview. Oil “is a merciless high-risk business. It’s the wrong business to over-promise and under-deliver in.”

Pimco Holdings

A bondholder group led by Pimco and BlackRock hired Rothschild to advise on an OGX restructuring, a person with direct knowledge of the agreement said last month, asking not to be identified because the selection process is private.

The $27.2 billion Pimco Income Fund (PIMIX), one of at least 25 Pimco funds that own OGX debt, boosted its holdings of OGX’s dollar-denominated bonds to $177 million in face value at the end of June, from $124 million at the end of 2012, according to filings compiled by Bloomberg.

OGX’s $2.56 billion of 2018 bonds and $1.06 billion of 2022 notes, which have lost investors more than 70 percent this year, were the worst-performing securities held by the fund, according to data compiled by Bloomberg. The 2018 bonds were the biggest contributor to losses within the fund this year among more than 3,800 debt securities held as of June 30, while the 2022 notes were the third-biggest, the data show.

‘Ongoing Evaluation’

Investors including Abu Dhabi’s Mubadala Development Co. sovereign-wealth fund and buyout firms are being asked to participate in the OGX capital increase, which could reach $500 million, and an OGX presentation to creditors was slated for this week, said the people with knowledge of the talks, asking not to be identified because the discussions are private.

OGX, based in Rio de Janeiro, declined to comment on questions about a possible debt restructuring, bankruptcy or the value of its bonds and assets.

The oil producer hired Blackstone Group LP “for the ongoing evaluation of its capital structure,” according to an Aug. 14 statement. Batista also hired Angra Partners to oversee a reorganization of his EBX Group Co. holding company, a person with knowledge of the contract said Aug. 30.

‘Zero’ Value

In Batista’s latest asset sale, Mubadala and Amsterdam-based commodities trader Trafigura Beheer BV agreed to buy a controlling stake in the former billionaire’s iron-ore port, his MMX Mineracao & Metalicos SA mining company said this week.

ATP, whose erroneous bets on offshore geology led it to miss output targets and run out of cash like OGX, obtained debtor-in-possession financing of $654.4 million when it sought Chapter 11 bankruptcy protection a year ago, Bloomberg data show. The company failed to become profitable and agreed May 7 to sell its assets to lenders led by Credit Suisse Group AG, which had precedence over bondholders, for $691 million.

For OGX, a bankruptcy could also push the value of the bonds close to zero because the country’s petroleum regulator, known as ANP, may take over the concessions that currently support the value of the bonds, according to Omar Zeolla, a corporate credit analyst at Oppenheimer & Co. in New York.

“There is a scenario with OGX where it goes to zero,” Zeolla said in a telephone interview. “In the case of default, the regulator could take those concessions away.”

Increasing Concern

OGX has 30 oil and natural gas concessions in Brazil that may be revoked if it files for bankruptcy protection, according to contracts it signed with the oil regulator. ANP said it will adhere to the concession contract in an e-mailed response to questions, without elaborating.

Bond investors are becoming increasingly concerned OGX will sell assets before going into bankruptcy protection to pay other creditors of Batista’s EBX, leaving them with less value to recover, Seaport’s Roche said.

“It’s a bit nerve-racking for some of our clients,” Roche said. “It’s the fear of negative conveyance, using assets to take care of particular creditors.”

EBX owed about $1.5 billion to Mubadala, three people with knowledge of the matter said in July. Itau Unibanco Holding SA, Brazil’s largest lender by market value, had about 5.5 billion reais ($2.4 billion) in outstanding loans to EBX, two people with direct knowledge of the matter said in March. Batista borrowed about 4.8 billion reais from Banco Bradesco SA, the people said. BTG Pactual’s outstanding loans to companies linked to Batista total about 650 million reais, a person with knowledge of the financing said in July.

Brazilian Courts

While bankruptcy laws in Brazil are similar to those in the U.S., the South American nation’s courts would probably make OGX creditors’ plight even worse than for those of ATP because the system is slower and has been less inclined to side with creditors, Thornburg’s Brady said.

“The OGX story is much more complicated from an ownership structure and from a Brazil standpoint,” said Brady. “Not only is it in Brazil, it’s in Brazil with a guy that has some resources, and he’s going in a whole lot of different directions, versus a U.S. case where it’s cleaner.”

ATP and OGX both bought offshore leases by themselves in regions dominated by major oil companies that have the financial resources to survive exploration setbacks. Usually, an oil startup takes a minority stake offshore with a more experienced, larger partner to ease the risks of dry holes and cost overruns, according to Christine Besset, a credit analyst at Standard & Poor’s.

‘Catastrophic Effect’

“When you see small companies, they usually have maybe a 20 percent, 25 percent interest in a well, a working interest with a major,” Besset, who covered ATP until it went into bankruptcy, said by telephone from Houston. “Being very small and having very risky assets, it puts you in a position where anything that goes wrong can have a catastrophic effect.”

ATP failed to meet production targets at offshore fields in the Gulf of Mexico and was also hit with permitting delays after BP Plc’s 2010 spill at the Macondo well in deep waters.

OGX has abandoned areas off Rio’s coast that it previously declared commercial because the geology is more compartmentalized and has less pressure than the company anticipated, hindering the flow of oil. OGX bought seven offshore licenses in the southern end of the Campos Basin off Rio’s coast in 2007, and was the sole investor in five of them.

No Guarantee

Its one partner, A.P. Moeller-Maersk A/S (MAERSKB), which has been producing in the North Sea since 1972, reduced its stake in two licenses in 2012 and handed operatorship to OGX. ATP had an average working interest of 81 percent at its licenses before going into bankruptcy a year ago.

Even if creditors reach a restructuring deal with Batista and agree to take equity as payment, there’s no guarantee they will end up with more than ATP’s bondholders, Zeolla said.